Markets vs Management: What Drives Profitability? TORIo Jaime A Roquebert; Robert L. Phillips; Peter A Westfall Strategic Management Journal, Vol. 17, No8(Oct, 1996), 653-664 Stable url: http://links.jstor.org/sici?sici=0143-2095%28199610%2917%03a8%03c653%3amvmw%27p903e2.0.c0%3b2-e Strategic Management Journal is currently published by John wiley sons Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/jwiley.html Each copy of any part of a jSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support@jstor. org http://www」]stor.org Wed nov204:19:11200
Strategic Management Journal, VoL. 17, 653-664(1996) MARKETS VS MANAGEMENT: WHAT DRIVES' PROFITABILITY? JAIME A. ROQUEBERT ROBERT L. PHILLIPS and PETER A WEStFALL College of Business Administration, Texas Tech University, Lubbock, Texas, U.S.A This study addresses the issue of the relative degree of variance in ROA accounted for b ndustry, corporate, and sBU effects while controlling for the business cycle and the interaction between the business cycle and industry. Two key articles, Schme (1991), are discussed in detail Research results on a recent data base(COMPUSTAT), using variance components analysis (VARCOMP) are presented that not only confirm most of the Rumelt(1991) findings, but also suggest the existence of a corporate effect, heretofore The debate between researchers in industrial The paper has three sections that parallel the organization economics (IOE) and the field of above purposes. First, we briefly review the theo strategic management (SM)concerning the ques- retical background, followed by an extensive tion of the principal source of profits(markets or comparison of the two head-to-head articles on organizational behavior) has been going on for the topic. Next, we present the results of our more than 50 years. Perhaps the term 'debate' is empirical analysis. Finally, we suggest a possible somewhat strong in that there has not been so reconciliation of differing findings and extend the much of a debate as a case of neglect. The key theoretical relationship between corporate diversi question of the principal source of profits appears fication and corporate effects on sBu profitabil- to have had very little influence on the further ity development of theoretical orientations in both the IOE and the SM fields, each acting as if its view were dominant-industry for IOE, manage THEORETICAL BACKGROUND ment for SM. Only recently have researchers from both fields gone head-to-head so to speak Ed Mason, the 'fatherof IOE, argued in the The present research attempts to build on the late 1930s that there was a rather deterministic head-to-head'research by(1) contrasting and association between market structure and profita- comparing key methods and findings on the topic, bility(Mason, 1939 ). The logic of the argument (2)investigating the issue further by pitting the rested on the premise that structural character IOE model against the quintessential SM model, istics of the industry or market, typically oper using a relatively recent, broad sBu panel span- ationalized through summary measures such as ning 7 years, and (3)exploring possible reasons concentration (Lenz, 1981), placed constraints on or any divergence with previous research find- the conduct (or strategies)firms could pursue The constrained conduct, in turn. led to differen- tial performance among firms according to the ROA: ind 1939). within the IOE field, firms in an industry were CCC0143-2095/96/080653-12 Received 4 April 7994 o 1996 by John Wiley Sons, Ltd Final revision received 5 December 1995
654 J. A. Roquebert, R L. Phillips and P. A. Westfall thought to be alike in all strategically important ation-specific'( Porter, 1991: 97). It was respects except for scale, and therefore, the focus implicitly assumed that managers'perceptions or unit of analysis was the industry(Weiss, 1971; and choices largely accounted for the variance in Rumelt, Schendel, and Teece, 1994). The early companies' performance. The emphasis on taking industrial organization economic work was also a general manager's perspective led to a largely concerned with capturing complexity: conse- process-oriented, as opposed to a content-oriented quently, explanations were based upon detailed stream of research( Porter, 1981) and extensive industry studies( Porter, 1991) Investigation of the evolution of organizational It should be pointed out that Mason was not theory models suggests a somewhat in-between the only theorist commenting on the subject. Even view of the world. As in industrial organization at the time, there were theorists arguing what we economics, performance models in organizational might now suggest belongs to the genre of the theory have been largely deterministic(White and resource-based theory of the firm. Nourse and Hammermesh, 1981). However, until recently the Drury(1938)suggested that influences specific theory and measures of environmental(industry) to the firm determined performance; i.e., manage- influence have been distinct from those employed ment basically determined firm advantages and in industrial organization economics. Further, and firms were not simply at the mercy of industry more importantly, the 'determinism' was not only factors. Over 50 years have passed since Mason's from the influence of the external environment ( 1939)proposition with apparently little dampen- but also from the organization structure itself. In ing of the industry elan. Montgomery and Porter essence, the organizing principle was that the (1991: xiv-xv)affirm the importance of indus- structure of the organization and its fit to the environment determine the relative degree of role industry conditions play in the performance h here were major shifts during the decades of Present research continues to affirm the importan of individual firms Seeking to explain perform 1970s and 1980s in the strategic management ance differences across firms recent studies have and industrial organization economics fields, with repeatedly shown that average industry profitabil- respect to the unit of analysis, the reevaluation ity is, by far, the most significant predictor of of assumptions, and the relative focus across firm performance. It is far more important than fields. The reasons for shifting theoretical orien- it is now uncontestable that industry analysi tations appear to have been the inability should play a vital role in strategy formation classical economics to explain intraindustry ( Note: Montgomery and Porter, 1991, used a inductive nature of case studies, and perhaps a single article to support the above quotation- healthy'cross-fertilization between fields Schmalensee, 1985, which will be discussed in Masons deterministic approach implied that detail later ) comparisons across industries would be valid In contrast to the basic theoretical orientation while Nourse's hypothesis supported the notion of IOE, the strategy field seems to have germi- of intraindustry heterogeneity(Bass, Cattin, and nated in the early 1960s out of the case study Wittink, 1977: 194 ) Further, the feedback loops tradition at Harvard(Teece, 1990). Learned of cause-effect-cause relationships regarding al.(1969)and Andrews(1971)constituted for environment, conduct, and performance would the most part the organizing framework that render purely deterministic theories unreconcil Ba 1991). In the classic strategy model, a firms competi- Recently, a 'new'stream of research has tive advantage was gained from a combination of reemerged by the name of resource-based the- external and internal factors, known as oppor- ories, which propose that firm idiosyncrasies in tunities and strengths applied against threats and the accumulation of unique and inimitable weaknesses. The early literature was developed resources create sustained competitive advantage around broad principles, reflecting an orientation (Barney, 1991; Collis, 1991; Conner, 1991; Lipp- toward prescriptions for practitioners and the 'rec- man and rumelt, 1982; Rumelt, 1984). It should ognition, indeed the preoccupation, with the fact be kept in mind that the seeds of this notion that competition was complex and highly situ- were present at the birth of the field (e. g, Nourse
Markets vs Managemen 655 and Drury, 1938). This rapidly developing body answer the question what is the relative impact of literature argues that the forgotten half of of industry factors vs. firm effects on financial Andrews model (the marshaling of internal performance? resources to develop distinctive competencies) Of all the past research, however, two studies needs to be brought back into the core of strategy dominate the literature. First is the classic article ( Bartlett and Ghoshal, 1991: 8-9). A clear impli- by Schmalensee (1985), cited earlier by cation of resource-based theory is the obvious Montgomery and Porter (1991) in support of their choice of unit of analysis; namely, that it requires emphasis on industry factors. Schmalensee(1985) a focus on the individual firm investigated estimates of the relative importance G A highly important second implication relates of firm(corporate ), market(industry ), and market the methodologies suitable for organization share on business unit profitability. He used the studies. Since idiosyncratic attributes rep Federal Trade Commission(FTC) line of business source of competitiveness, a reliance on detailed (LB )data for 1975 and both regression analysis ase studies, or at least in-depth analysis, appears and an analysis technique that was then unique to to be required. It do st. at least at the ioe lite first glance, that resource-based theory should (See Appendix 1 for further discussion) supplant the traditional and well-established IOE Schmalensee (1985)concluded his regression frameworks, but rather that it supplements them. and variance component analyses with four prop What we have seen then, in essence, is the ositions, two of which are relevant to the present strategic management field coming almost full work. The relevant propositions state that circle in terms of what early policy researchers (1) firm effects do not exist, and(2)industry identified as the basis for good strategy formu- effects exist and are important, accounting for at lation'( Collis, 1991: 65) least 75 percent of the variance of industry rates The deterministic vs. choice orientation of the of return on assets(Schmalensee, 1985: 349) effectiveness research does not account solely for The second major work to address the relative differences in units of analysis(as shown by part variance question was that of Rumelt(1991), of the organization theory literature), but rather who explored the variance accountability issue of each approach brings with it different perspec- industry vs. other factors. Because Rumelt(1991) tives, biases, and methodologies. As Rumelt was concerned with Schmalensee's(1985)use of (1974: 560)points out: a single year's data, he extended Schmalensee's he mismatch arises because polic (1985) methodology to cross-sectional and time researchers and economists have been interested series data by using 4 years'worth of data, and substantially different phenomena. The central included a term in his equation not only for oncerns of business policy are the observed corporate management( what Schmalensee, 1985 heterogeneity of firms and firm's choice of called firm effects ), but for SBU level manage- oduct-market commitments. By contrast, the ment also basic phenomena of interest in neoclassical theory is the functioning of the price system under norms of decentralized decision making COMPARING SCHMALENSEE (1985) It should also be added that economists tend to TO RUMELT(1991) see firms as players in a multifactor economic game, and their interest is in the game and its Schmalensee(1985) used the Ftc lB data for outcomes, rather than in the particular play or the year 1975. SBU returns on assets (ROAs performance of individual firms'(Nelson, 1991: were decomposed by an equation in the form 61) rom the foregoing discussion, it is apparent ri=H+a;+B;+ ySy+ei that there are opposing assumptions about the strength of environmental forces(choice or where ri is the rate of return of firm is operations determinism) seen in different literatures. Second, in industry j(SBU ROA); S is the market share; each set of assumptions implies justification of a are firm effects, p are industry effects, u and fferent units of analysis. In light of these two y are constants; and e are disturbances arguments, the strategy field has recently tried to Schmalensee (1985: 343-344)stated that
656 J. A Roquebert, R. L. Phillips and P. A. Westfall whereas none of the coefficients in the specified by year interactions, o represent the SBU effects, equation could be given a'defensible structural and E represent error. Variances associated with interpretationthe model taken as a whole could particular effects address" the relative merits of at least the extreme 02, and o2 versions of the classical, revisionist, and mana- Since Schmalensee (1985)used only a single genial positions. The relative magnitudes of the years worth of data, if we were to translate variables would suggest support or lack of support Schmalensee's model using Rumelt's specification for each (t= l year)we would have Schmalensee (1985: 344)tested for the nce of industry effects (nonidentical B), corpor- rikl =u+a+Bk+ y1+8n+i E(4) ate effects (nonidentical a), and share effects (nonzero y), using ordinary least squares and =(μ+Y1)+(a1+8a)+Bk+(中+E) the usual F-statistics. The results indicated that =H+a+βk+∈ corporate effects simply do not exist ( Schmalensee, 1985: 346). In contrast, tests for As pointed out by Rumelt(1991), it is clear that the existence of industry and share effects were persistent effects(oi and di) are not estimable significant at least at the level of 0.045. Schma- when only 1 year of data is considered; time- lensee (1985)reformulated his basic model leav- series data is needed to isolate their effects out the term representing corporate effects, In Schmalensee's (1985)model, industr he as(see Equation 1), and applied the effects'are the combined effects of industry and riance component analysis. His results allocated industry-time interaction in Rumelt's (1991) less than 1 percent of the variance to share model. It can also be seen that Schmalensee's effects, 19.5 percent to industry effects, and the error effects' are the combined effects of error remaining variance(80%)to error and the persistent SBU effects of Rumelt's model It should also be noted that Schmalensee(1985: The corporate effects are the same in both mod- 345)addressed the issue of whether or not it is els. It should be noted that Schmalensee con- defensible to work with industry-level data, i. e, sidered a market share variable in the variance examining the average SBu Roa by industry. component analysis; however, its contribution to y so doing, his basic equation then became variance explained was negligible (less than 1 percent), and will not be included in the remain R;=u+B +terms in as, Ss, and es(2)der of the discussion. Assuming that all effects are independent, the variances are related as fol where R, is the average SBU ROA for industry lows(anything with a prime refers to Schmalen- j. He then suggested that industry- level analysis see‘ s model):2=σa+ os and o2=σd+σ2 would to be sensible if estimates of the The theoretical corporate variance, o3 is identical variance of B(industry effects)are large relative in both models to the cross-section variance of the R, Thus, Schmalensee's(1985) industry effects (Schmalensee, 1985: 345 ). It was through the (about 20 percent; from Table 1, p. 348)corre- latter analysis that he found that the industry sponds to the sum of Rumelt's(1991)industry effects in Equation 2 accounted for over 75 per- year interaction, plus "industry variance compo- cent of the variance nents(about 16 percent), as given in Rumelt's As indicated above, Rumelt (1991) used the (1991) Table 3, p 178.(Note: Rumelt, 1991 ame data as Schmalensee but added to it the drew two samples, A and B. Sample a closely data for the years 1974, 1976, and 1977. Rumelt followed Schmalensee's, 1985, selection pro- (1991) then postulated the following model cedure and, among other things, excluded all BUs with sales less than 1 percent of the FtC r=+Q1+阝k+Y:+8n+中读+∈(3) industry total sales for a given year. Sample B was an expanded Sample A through the addition ere rikt represents the sBu rOa for a given of smaller SBUs) SBU of corporation k in industry i in year t; a Schmalensee's estimate of o2(error)is about are industry effects, B are the corporate effects, 80, whereas Rumelt's estimate of o2+o2 y represent the year effects, 8 are the industry (combined error and SBU effects )is 83 percent-